One of the biggest questions among would-be homeowners is whether it’s cheaper to continue renting or to buy a house. Knowing the answer to this complex question can make the difference between using the local market to your advantage or overstretching your finances. But are there any hard and fast rules applicable across the board? In this post, we’ll take a closer look at recent figures and try to find an answer to this age-old question.
Saving for a 20% Down Payment
The main hurdle all homebuyers face is saving up for a down payment on their home. And yet, there’s a significant gap between homebuyers’ expectations and reality.
One of our recent studies found that, although many Millennials hope to buy a house within a year, they still grossly underestimate the actual costs. The U.S. national average for a down payment is $62,000, yet 40% of Millennials expect it to be closer to $10,000. What’s more, 61% had less than that in savings, while 14% had no savings at all.
When drawing out a savings plan for a down payment, it’s important to set a realistic figure but also factor in other expenses. Can you continue paying rent while simultaneously saving for a home, putting money into an emergency fund, paying off high-interest debts, or setting money aside for retirement?
Many experts recommend using the 50-30-20 budgeting rule: spend 50% of your income on essentials, allocate 30% for leisure and save the remaining 20%. Take the time to determine early on whether that 20% of your income can accommodate all your savings needs.
Don’t forget to take the hidden costs of home buying into account. From appraisals and inspections to closing costs and agent fees, there’s more to budgeting for a home than just saving for the down payment.
Rent vs. Mortgage Affordability
It’s essential to assess how local market fluctuations will impact your housing budget in the long run. One of our reports highlighted that mortgage affordability has worsened in 15 out of the 100 largest cities in the U.S. in the past decade. As a result, homeowners now need to pay more than 30% of their income on mortgage, which is higher than the figure recommended by experts. According to the study, in the most unaffordable cities, homeowners need to boost their income by up to $43,567 to avoid being cost-burdened.
At the same time, the rise in income is nowhere near enough to meet the increase in home prices, and in some cases, the difference between home price growth and income growth exceeds 50%.
Similarly, changes in the rental market pack their own share of good and bad news. According to RENTCafé, rents have increased in 13 of the 30 largest U.S. cities, yet they’ve decreased or stagnated in 18. Another encouraging finding for tenants is that rates dropped in all of the top 10 most expensive large cities for renters.
So, depending on the local figures, it might be cheaper to rent than buy in some areas, while it can be more accessible to buy than rent in others.
Crunching the Numbers: Rent vs. Mortgage Payments
One of the most common arguments used in the rent-vs-buy debate is that if you can afford to pay a certain amount in rent, you can afford to pay the same amount in mortgage. In reality, however, budgeting is rarely that straightforward. Here are two rules that can help you better assess your budget:
- The 30% rule: aim to spend no more than 30% of your gross income on housing costs;
- The 5% rule: apart from mortgage, expect to pay an additional 5% of your property value on irrecuperable costs: property taxes (1%), property maintenance (1%) and interest rates (3%).
If your housing budget is within that 30% sweet spot, while also factoring in irrecuperable costs, then switching from rent to mortgage is something worth considering. It’s also worth bearing in mind that, as a tenant, your utilities are often included in the rent, and you don’t have to contend with property taxes, HOA fees, maintenance and upkeep, and so on.
What Money Can’t Buy
The decision to buy or rent hinges heavily on their financial implications. Yet, there are some arguments in favor of each that no amount of budgeting can take into account.
On the one hand, renting comes with a lot of flexibility and freedom to relocate, depending on your lifestyle or career choices. You don’t need to worry about a drop in property value, the stress of committing to a lengthy mortgage or having your home foreclosed due to unemployment.
On the other hand, owning your home provides you with a greater feeling of stability. There are tax breaks you can take advantage of, investment opportunities in the form of renting out, and a gradual build-up of equity.
Ultimately, there is no one-size-fits-all scheme, and the decision to buy or rent is a personal one. But before making up your mind, be sure to consult a financial professional for your specific case.